(Editor’s Note. The following article is an edited version of a position paper we prepared for a client. Our client asked us to evaluate their indirect rate structure – method of allocating indirect costs to final cost objectives – since they were expecting some of their contracts to become covered by the cost accounting standards (CAS) and wanted to determine if they had potential compliance problems. We decided to present the position paper here because it illustrates many of the issues that contractors need to consider when designing or altering their indirect rate structure, whether or not they are CAS covered. We have disguised our client’s name – calling it "Contractor" - and names of its overhead rates and have eliminated some of the topics addressed in the paper.)

In response to your request, we have evaluated Contractor’s indirect rate structure, identified potential CAS non-compliances and recommended some relatively modest changes.

Contractor currently maintains five separate indirect rates. The current indirect rates are as follows:

1. General Overhead. This is the primary overhead rate that is applied to Contractor’s primary lines of business such as systems engineering.

2. Capital Overhead. This rate is used for work requiring a relatively high level of asset utilization where the pool of costs reflect higher facilities, infrastructure and depreciation costs. The rate is applied to certain research and development as well as production projects.

3. Special Overhead. This rate is used for work where there is a relatively high rate of labor utilization resulting in lower non-direct labor as well as lower facility and equipment costs.

The allocation base for the three overhead pools identified above is a direct labor dollar base consisting of direct labor of individuals assigned to the respective pools, as well as B&P/IR&D labor dollars.

4. Material and Subcontract Handling. For purchases of direct material, direct subcontract and direct consulting dollars in excess of $50,000, Contractor segregates and accumulates the indirect expenses associated with these purchases (e.g. subcontract administration, purchasing) and allocates these costs on a base consisting of these direct expenses.

5. General and Administrative (G&A). Contractor’s G&A pool includes expenses related to operating the entire company and includes a prorata share of home office expenses. The allocation base is a modified value-added base consisting of all costs except those costs included in the material and subcontract handling base. Note the G&A base includes direct material, subcontract and consulting expenses that are less than $50,000.

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